Whilst a week might be a long time in politics, it is several lifetimes in the cryptocurrency world, as the UK’s financial regulators have revealed a change in the rules surrounding crypto investment and payment cards.
Following the announcement in late April that ‘cryptoassets’ would be regulated by the Financial Conduct Authority with similar rules to traditional finance, the FCA has already started to showcase what this brave new world for UK crypto will look like.
The FCA’s most recent discussion paper touches on a wide range of topics in the sector, but could have the potential to fundamentally change several major parts of the crypto investment sector in an attempt to balance innovation and oversight.
Whether it will succeed will depend a lot on implementation, but here are some of the proposed changes to the market.
Banning The Use Of Credit Cards To Buy Crypto
According to a YouGov study commissioned by the FCA, the percentage of people who paid for cryptoassets more than doubled from 6 per cent to 14 per cent, something that could become a problem in the event of a sudden and sustained market downturn.
The volatility of many cryptocurrencies means that, much like in the stock market, there is the potential for people to lose money as well as make it.
That is fine, as long as an investor uses their own money responsibly and does not invest more than they can afford to lose.
However, using credit or borrowing money to fund investments in a volatile market can have serious consequences, including risking secured assets or even a person’s home.
Exactly how the proposals would work was still a matter for debate, including both what counts as using credit and which cryptoassets would be exempt from the rules.
Examples of the latter cited by the discussion paper include using credit cards as well as using a credit line to purchase cryptoassets, whilst FCA-approved stablecoins were cited as a potential exception to the rules.
Restricting Cryptoasset Lending And Borrowing
The FCA rules would naturally affect the crypto lending and borrowing markets, which operate in parallel as an alternative form of access to cryptocurrency capital.
Cryptocurrency lending typically means putting money into an investment pool and receiving a yield in return, whilst borrowing involves receiving a certain amount of crypto that is paid back with interest later.
Whilst institutional investors would still have access to this part of the market, the FCA has suggested a range of propositions to ensure that people who end up involved with lending or borrowing are subject to checks similar to Know Your Customer regulations.
This would potentially include credit checks, limiting the automatic topping up of collateral, restricting the use of platform tokens to gain more favourable terms, restricting cryptoasset borrowing to only stablecoins or even requiring customers to answer questions on investment and cryptocurrency.
These rules would be the most restrictive and appear to be the least likely to be passed in full, as they would effectively warp or even stop the market entirely.
More Transparent Staking
As many blockchains use a proof-of-stake verification method for validating transactions as opposed to the proof-of-work model used by Bitcoin, staking has increasingly become desirable as a method for potentially generating returns.
Because staking requires cryptoassets to be locked up for a potentially long time, rewards and
incentives are often offered to people who stake the relevant tokens, but as the rules surrounding staking requirements are not always consistent, some customers may not understand the implications of staking.
The FCA aims to fix this by requiring a more transparent approach based around the legislative amendments that make it clear that staking is not a form of collective investment, with tighter restrictions on record-keeping and disclosing key information.
Threading The Needle
As with the regulation of decentralised finance more broadly, the FCA is attempting to balance two diametrically opposed concepts, and will need to be careful in addressing how it achieves this in order to ensure that DeFi investors feel confident in investing in the UK whilst also protecting customers.
Some aspects of the rules are likely to be a cause for concern in some cryptocurrency circles, either through the actual policies proposed or by the implication of restricting certain types of market behaviour.
Regulation is an inevitable consequence of how crypto has evolved, but it has paid dividends in the United States and the EU, where the closer ties between DeFi and traditional finance have led to far greater investment into the cryptocurrency market.
This could potentially happen again in the UK, as long as innovation is not stifled.